Given the fact that Social Security benefits are taxable when you exceed certain income thresholds, your financial professional(s) should design a Social Security plan for you that includes strategies for minimizing Social Security taxation and maximizing your after-tax Social Security benefits.
As pointed out in Part 1 of this post, there are two types of planning opportunities: (1) Pre-benefit receipt and (2) Ongoing benefit receipt. Part 1 discussed various pre-benefit receipt strategies, including mentioning the importance of analyzing and potentially implementing them beginning in one’s 40’s. Once you flip the Social Security switch and start receiving your benefits, while you generally won’t be able to control the amount or timing of your benefits, there are nonetheless opportunities available to reduce the amount of taxable benefits as well as the amount of tax attributable to your benefits that you ultimately pay. Strategies for reducing taxable benefits will be discussed in this post and Part 3. Part 4 will address reduction of income tax attributable to benefits.
Due to the fact that the thresholds are relatively low, reduction of taxable Social Security benefits can be challenging, to say the least. As shown in Exhibit 1 of the January 17, 2011 post, Say Goodbye to Up to 30% of Your Social Security Benefits – Part 2 of 2, assuming that your filing status is single, once your “combined income” exceeds approximately $49,000, 85% of your Social Security benefits will be taxable.
As discussed in the last three posts, there are three components of “combined income:” (1) 50% of Social Security benefits, (2) adjusted gross income, and (3) tax-exempt income. Components #1 and #3 will be addressed in this post, with adjusted gross income reserved for Part 3.
50% of Social Security Benefits
Unless the benefit start date has been deferred (see the five-part Do Your Homework Before Flipping the Social Security Switch series beginning on October 11, 2010 and the November 15, 2010 post, Wait Until 70 to Collect Social Security?) or the “file and suspend” strategy (see the December 13 and 20, 2010 posts, Breadwinner Approaching Social Security Retirement Age? – File and Suspend – Parts 1 and 2) has been employed in the case of a married couple to suspend the receipt of the breadwinner’s Social Security benefits, component #1, 50% of Social Security benefits, cannot be controlled once payment of benefits begins. Whatever amount of Social Security retirement benefits you and your spouse, if married, receive, 50% of the gross amount will be included in the calculation of “combined income.”
Component #3, tax-exempt income, was discussed in Part 1 of this post. Since the calculation of taxable Social Security benefits is unfavorably impacted by tax-exempt income, while it may be beneficial to you for other reasons, inclusion of tax-exempt investments as part of your investment portfolio won’t be of much use to you when it comes to minimizing taxable Social Security benefits. While this factor generally isn’t considered by most investment professionals when designing an investment portfolio, it should be.
The third component of “combined income,” adjusted gross income, provides for the most opportunities for reducing “combined income” and, in turn, the greatest potential for reducing taxable Social Security benefits. Part 3 is devoted to a discussion of strategies for reducing adjusted gross income.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.